Acquisitions are a key part of business growth. If you’re at the stage where you’re vetting potential companies for acquisition, then you’re doing it for a certain reason. Maybe you want to increase your market share. Maybe you're keen to access new technologies at scale, so you don’t have to build them from scratch. Or maybe there’s a competitor doing what you do - only better - and poses a competitive threat. So, acquiring them makes strategic sense. All these reasons come down to one thing: you want to grow the business.
As Roger L. Martin said in the 2016 issue of Harvard Business Review, “M&A is a mug’s game, in which typically 70-90% of deals fail.” Let that sink in for a minute. There’s no single reason a business acquisition fails. Difficulty integrating two companies across teams, technologies and strategies can often cause issues post-acquisition. A mismatch in cultural alignment and strategy can play a part too. And poor due diligence often ranks high on the list of reasons.
If you want to make sure your business acquisition doesn’t fail, here are 5 ways you can future proof your business acquisition.
1: Watch out for misleading financials and inflated earnings
Remember when Hewlett-Packard acquired Autonomy in 2011 for $11.1 billion? Let me refresh your memory. The goal was to catapult HP into a software and services company. But it ended up backfiring in a big way.
Nearly a year after the acquisition, HP was all over the news alleging that the British software company Autonomy was guilty of “serious accounting improprieties” and a “willful effort to mislead shareholders.” More specifically, HP accused Autonomy of inflating its revenue and gross margins to mislead potential buyers. It turns out that Autonomy mislabeled revenue from low-end hardware sales as software sales and booked licensing deals with partners as revenue when it wasn’t.
Why am I bringing this up? Because I don’t want you to fall into the same situation as HP did. So, how can you avoid that?
- Don’t just review the company’s financials at face value. Take a deep dive into the sales books and ledgers to make sure all revenue that’s booked is actual revenue.
- Pay attention to accounting fraud. Is the company’s revenue growing but its cash flow isn’t? Has there been a sudden surge in the company’s financial performance in the final reporting period of the fiscal year?
2: Review the company’s payment behaviors for the last 2+ years
When you’re looking at a potential acquisition, paying attention to how a company handles its payments is a must. It’s a window into their financial health, especially when it comes to cash flow and liquidity.
So, what should you look for in their payment behaviors?
- How quickly they collect payments: In their business credit report, you can look at their Days Beyond Terms (DBT) trends over the last 12 months. This indicates how late they pay their bills. So if their DBT has increased drastically (let’s say from 10 to 60 in a single month and then continues to rise significantly for several months), that would be a sign of cash flow issues.
- How consistent payment terms are: Check whether the company sticks to its payment terms or frequently extends them. Frequent changes in payment terms, like giving customers extra time to pay, might signal financial trouble. If they’re inconsistent, it can make cash flow unpredictable and might point to deeper financial instability.
- Aging accounts receivable: This refers to how long invoices have been sitting unpaid. If a lot of invoices are sitting unpaid for 60 or more days, that’s a problem. Old unpaid invoices can indicate that customers aren’t paying on time, and that could hurt the company’s liquidity. It’s a big red flag.
- Overall creditworthiness: Check the company’s business credit report. Look at how they’re seen by creditors and lenders and what their credit score has been over the last 12 months. Has their credit score worsened in recent months? Are they considered to be at a high risk of bankruptcy? A company with a low credit score and high risk is more likely to pay their bills late, which could affect your cash flow and revenue growth.
- Analyze the customer base you’re acquiring: Especially their payment habits. It’s not just about the company you’re buying but who they’re doing business with. If their accounts receivable are tied up in risky customers that pay late or default, you could be inheriting a major cash flow issue. Make sure you’re clear on who owes what and how reliable those customers are before finalizing the deal.
By keeping a close eye on how your customers pay their suppliers, you’ll be able to estimate how they manage their cash flow and how strong the business model is.
3: Research market dynamics and customer demand
When eBay acquired Skype for $2.6 billion in 2005, the ecommerce giant had big plans for Skype – believing it would revolutionize communication for users on the platform. They thought people would want to make voice calls during ecommerce transactions, thus improving the buying and selling experience.
But the market didn’t support this vision. Users didn’t prioritize voice communication the way eBay anticipated. Instead, they stuck to email and messaging, which were more convenient.
Despite significant investment, Skype didn’t drive the expected user engagement or revenue for eBay. The company had to recognize its mistake and write down the value of Skype by $1.4 billion in 2007, a huge financial loss. At its core, this acquisition was a hard lesson in how failing to properly research market dynamics and customer demand can lead to poor financial outcomes.
In 2009, eBay sold 65% of its stake in Skype for just $1.9 billion, which was less than they originally paid for it. The sale didn’t bring eBay the return they expected and it reflected a significant misstep in assessing the value of Skype within their business model. Ultimately, Microsoft acquired Skype in 2011 for $8.5 billion, capitalizing on the potential Skype had as a video conferencing tool and communication platform for businesses.
So, what could you do to avoid falling into the same trap as eBay?
- Survey target customers to get feedback on the demand for your combined service/product
- Assess what’s offered by competitors to understand how the acquisition will give you the competitive advantage
4: Assess the attractiveness and feasibility of a target acquisition
When I say attractiveness and feasibility, I don’t mean how fancy or cool the target company’s branding is. I’m talking about the amount of debt they have on their books and the long-term scalability and growth of the business.
Most businesses have some amount of debt on their books. But if you want to acquire a company, you need to get a clear picture of how they manage debt and their debt-to-equity ratio. This is where research on equity and debt comes into play.
Debt research looks at how much debt the company is carrying and whether it can handle the financial burden of a merger or acquisition. If a target acquisition company has too much bad debt and can’t handle making repayments, the lender or bank could end up taking over. That means you could lose your investment. And that’s definitely something you want to avoid. Depending on how much debt a target acquisition has on its books, you may have to assume that debt on your balance sheet. But there are other options – you could deduct that debt amount from the sale price to minimize your risk. You could also negotiate with the lenders to lower the overall target company’s debt so you can lower the total acquisition cost on your business.
Now let’s talk about equity research. This is key for doing independent research and analysis on the value of a target acquisition. It’s going to reduce the chances of being bamboozled by inflated market hype and inaccurate information. It’s pretty common for the target company to hype up their value during the acquisition talks. But equity research can help avoid that and make sure you’re getting an honest ‘second opinion.’
And don’t forget to evaluate their inventory. Are stock levels aligned with current and future demand? Is inventory sitting idle or turning over quickly? Poor inventory management can tie up capital, distort profitability, and signal deeper operational inefficiencies. Getting clarity on how inventory is handled can help you avoid surprise write-downs after the acquisition closes.
5: Avoid overvaluing a target acquisition’s worth
We’ve all heard the stories of companies that were overvalued. Remember AOL’s acquisition of Time Warner? The $165 billion deal failed – mostly because of cultural clashes between both companies and misleading information about the new media landscape. And then, there was the painful acquisition of Motorola by Google – something that was intended to help Google take control of the Android operating system. But industry experts said Google overpaid – especially since Motorola’s smartphone business struggled against other competitors like Samsung.
The lesson from these two examples is that overpaying for an acquisition happens more often than you realize. Usually this happens because enough due diligence hasn’t been carried out, synergies are overestimated and strategic planning is an afterthought. Obviously, you don’t want this to happen to you when you’re acquiring a company.
Here’s a few things you can do to avoid overvaluing a target acquisition:
- Ditch your gut and focus on the numbers: Methods like Discounted Cash Flow (DCF), EBITDA multiples, and revenue multiples are standard for assessing a company’s worth. DCF looks at the company’s future cash flows adjusted for time and risk, while EBITDA multiples focus on earnings potential. These methods give you a clearer financial picture and help you avoid inflated valuations based on unrealistic expectations.
- Focus on current value, not the future: It’s tempting to base your valuation on what a company could be worth in the future. However, future projections are often speculative. While it’s important to consider potential growth, focus on the company's current performance and historical trends. Overly optimistic growth assumptions can lead to inflated valuations, causing you to overpay.
- Do a competitive SWOT analysis: Do a thorough review of what competitors currently offer and identify their strengths, weaknesses, opportunities and threats. Use industry multiples or look at recent transactions in the sector. This provides a baseline for what similar companies are worth and can help prevent overvaluing a company based on unrealistic projections.
- Run multiple valuation scenarios: Use multiple approaches to get a well-rounded view of the target’s worth. Combining methods like DCF with revenue multiples or precedent transactions helps ensure your valuation is grounded in reality and reduces the risk of overpaying.
Frequently Asked Questions
Can I spot red flags in a company’s financials before an acquisition?
Start by digging deeper than surface-level revenue figures. Look for signs of accounting fraud, like revenue growth without matching cash flow, or sudden performance spikes at year-end. Review ledgers and check whether the revenue is real, consistent, and booked accurately. If something feels off, it’s worth investigating.
What role does market research play in successful acquisitions?
Market research helps you understand if the acquisition makes strategic sense. If customer demand doesn’t support your vision for the combined business, it can lead to big losses. Check competitor offerings, talk to potential customers, and make sure the acquisition will strengthen your position in the market - not weaken it.
Why is it important to check payment behavior before buying a business?
Payment trends give you a window into a company’s cash flow and financial health. Look at how quickly they pay suppliers, the consistency of their payment terms, and whether they have overdue invoices. A business that delays payments or has aging accounts receivable could be facing liquidity issues and that risk becomes yours after the acquisition.
How can I avoid overpaying for a business acquisition?
Rely on solid valuation methods like Discounted Cash Flow (DCF), EBITDA multiples, and recent industry transactions. Avoid banking on future growth alone. Focus on the company’s current performance and run different valuation scenarios to keep expectations grounded and avoid costly overvaluation.
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About the Author
Lina Chindamo, Director, Enterprise Accounts, Creditsafe
Lina Chindamo is a Certified Credit Professional (CCP) with over 25 years of experience in credit risk management. She has held senior leadership roles with leading companies in multiple industries in the Canadian market such as Sony Electronics, Maple Leaf Foods, and Mondelez Canada. Her experience as a credit professional along with her current role as Director, Enterprise Accounts who works closely with c-suite partners and credit teams across all industries makes her a well-rounded credit professional who is well respected in our industry.
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